Rev. Rul. 89-55

1989-1 C.B. 268, 1989-15 I.R.B. 14.

                       Internal Revenue Service

                                 Revenue Ruling

                     TRUSTS; QUALIFIED SUBCHAPTER § TRUSTS

                           Published: April 10, 1989

Section 1361. - § Corporation Defined

  Trusts; qualified subchapter § trusts. A trust is not a qualified subchapter § trust (QSST) if the terms of the trust instrument provide that in the event the trust does not hold shares of an § Corporation, the trust may terminate during the life of the current income beneficiary and distribute its corpus to persons other than that beneficiary.

ISSUE

  Is a trust the terms of which provide that in the event the trust does not hold shares of an § corporation, the trust may terminate during the life of the current income beneficiary and distribute its corpus to persons other than the current income beneficiary a qualified subchapter § trust (QSST) under section 1361(d)(3) of the Internal Revenue Code?

FACTS

  X is a small business corporation that made a valid election for 1986 to be an § corporation. In 1987, A transferred shares of X to a trust, T, for the benefit of A's children, C and D. C and D are successive income beneficiaries of T. The terms of the trust instrument satisfy the requirements of sections 1361(d)(3)(A)(i) and (iii) and of 1361(d)(3)(B) of the Code for QSSTs.

  The trust instrument provides that corpus is to be distributed only upon the termination of T, and generally, that T may not terminate while either C or D is alive. However, if T no longer holds any shares of X, then T may terminate and distribute its assets to C and D equally or to their issue per stirpes.

LAW AND ANALYSIS

  Section 1361(a)(1) of the Code defines the term 'S corporation' as a small business corporation for which an election under section 1362(a) is in effect for the taxable year. Section 1361(b)(1)(B) permits only individuals, estates, and certain trusts to be shareholders of a small business corporation. A QSST, defined in section 1361(d)(3), is one type of trust permitted to be a shareholder under section 1361(b)(1)(B).

  Section 1361(d)(3)(A)(iv) of the Code provides that a trust is a QSST only if the trust instrument provides that, upon the termination of the trust during the life of the current income beneficiary, the trust must distribute all of its assets to that beneficiary. In this case the question presented is whether the T trust instrument complies with this requirement because it provides the income beneficiary with the exclusive asset distribution rights only if T holds shares of X.

  The detailed requirements of section 1361(d)(3) of the Code restrict the permissible class of trust that may be shareholders of an § corporation under that section to those that are subject to the income and corpus distribution rights of one individual at a time throughout the existence of the trust. This is accomplished by ensuring that during the life of the current income beneficiary, all of the assets of the trust, if distributed, can only be distributed to that individual.

  In this case, if T no longer holds shares of X, then T could terminate during C's lifetime, and the assets of T could be distributed to more than one individual (C and D or their issue). Thus, the terms of the T trust instrument do not ensure that C will be the only distributee of T's assets during C's lifetime.

HOLDING

  A trust the terms of which provide that in the event the trust does not hold shares of an § corporation, the trust may terminate during the life of the current income beneficiary and distribute its corpus to persons other than the current income beneficiary is not a (QSST) under section 1361(d) of the Code.

DRAFTING INFORMATION

  The principal authors of this revenue ruling are Lon B. Smith and William Galanis of the Office of Chief Counsel. For further information regarding this revenue ruling contact William Galanis on (202) 377-9470 (not a toll-free number).

Rev. Rul. 89-55, 1989-1 C.B. 268, 1989-15 I.R.B. 14.